Understanding Credit Reports and FICO Scores

Using a minimum FICO score is a sound practice when evaluating an application and determining the risk of the tenant’s ability to pay rent in a timely manner. However, it is important to understand how a FICO score is calculated. Many owners and landlords make poor conditions in denying a rental application without understanding how a credit reports are scored.

A credit report is only one consideration for analyzing a renal application. FICO scores range from 400 to 850 and consider payment history, amounts owed on active trade lines (percent of credit being used), length of credit history, establishment of new credit, and type of credit. An applicant’s fico score will drop if he or she has a recent slow payment, collection, bankruptcy, multiple inquiries, judgment, or fully utilizes current trade lines (maxes out credit line). It is best to keep outstanding balances below 50% of your available credit.

We process many applications with low FICO scores. We frequently see credit reports with medical collections and no active credit lines. In these scenarios, a low FICO score is are a poor measurement in determining the tenant’s ability to pay rent. You must have active trade lines with recent payment activity to increase your credit score, and many tenants cannot afford or do not have health insurance. Strong employment and good rental history are much better metrics in analyzing the risks for a prospective tenant.

Was there a loss of employment two years ago, and the tenant has been employed for a year now and paid his/her bills on time the past year and has good rental history? What about a divorce situation? We see applicants with perfect credit for years until a divorce. During the divorce process, one spouse drove up credit card balances; mortgage was not paid; spouse failed to pay credit cards in a timely manner; and other spouse’s credit score dropped 100 points because all credit was held jointly with spouse.

Foreclosures are at an all time high in Austin. Did prospective tenant have a recent foreclosure? Applicant may have paid their rent on time for years as a tenant and purchased first home with a subprime mortgage with a two year balloon. The applicant’s mortgage payment increased, he or she has no equity in property, has a low fico score and cannot refinance the home. The adjustable rate mortgage increases $300 hundred per month and home goes into foreclosure.

What about a married couple, where a non working spouse has terrible credit and the husband had good credit? The husband is the bread winner and is financially responsible for paying rent. Does it really make sense to consider the credit score of the non income spouse? These scenarios need careful consideration.

Sometimes, we will process a rental application with a high fico score. Landlords usually celebrate. However, most high FICO score tenants usually buy a home in 1-2 years and rarely rent long term. High FICO score tenants can actually be less profitable and cost landlords more money from increased turnover and leasing expenses. The most profitable tenants have stable jobs, work hard to provide a home for their family, have little savings and a low FICO score. This profile tenant cannot afford to purchase a home and will rent for many years. I have several tenants in properties I personally own who have resided in the same home more than five years. Sometimes the tenants are late in paying rent if they have an unforeseen car problem or medical illness, but we always work out a payment plan.

Instead of denying an application based on FICO score alone, we may increase the security deposit for an applicant with a poor credit score. This assumes the applicant has no collections from landlords and good rental history. A double security deposit helps offset the risk of past credit problems.

Take the time to analyze the credit report and consider asking for a larger security deposit in lieu of denying the application. This can help avoid a vacancy. A monthly vacancy for a $1,200 rental property costs the owner the same as a tenant who did $1,200 of damage to the property. However, a double security deposit will help pay for damages. A landlord can’t recover lost rents due to a vacancy.

Feel free to call our office if you have any questions. We provide property management and leasing only services. We are also experts in helping investors purchase a rental property, find a tenant, and manage the property. Don’t purchase an investment property without using the services of a professional property manager and investor.